Sunday, December 23, 2007

Soviet Light Bulb Story, Revisited

Hey, it's a little slow for new postings, so I thought I'd recycle an interesting post from last December about the market for used light bulbs in the Soviet Union, especially because: a) I'm taking a group of MBA students to Russia in April 2008, b) Russia's Putin is Time Magazine's "Man/Person of the Year," c) my MBA students in MGT 551 are studying price controls in CH 4 of the Gwartney textbook and d) I didn't have a lot of regular readers last year at this time. Here it is: Economists generally oppose price controls because they distort markets, and cause either shortages (e.g. rent control) when there is a price ceiling, or surpluses (e.g. minimum wage) when there is a price floor. Shortages (excess demand) and surpluses (excess supply) represent an inefficient use of scarce resources, and economists support market prices because they eliminate shortages and surpluses, and therefore lead to efficiency.

From the Soviet Union, there are many examples of distortions and inefficiencies from its long history of price controls, but here is a real classic.

Light bulbs, like most other basic goods and staples in the Soviet Union, were often in short supply because the official price was below the market price, resulting in excess demand and prolonged shortages. As a result of the chronic light bulb shortage, an informal, black market developed in the USSR for used, burned-out light bulbs. That is, Soviet citizens would actually pay a positive price for a light bulb that didn’t work.

How would it be possible for a burned-out light bulb to have a positive price, when it would normally just be thrown out? Of what use could anybody have for a used light bulb? Think about it first, and read the answer here.

I am a former USSR resident as well and although I do not remember a light bulb shortage in specific, there was a general shortage of everything all the time. Long lines were the norm. Waiting for years to have a phone line installed was also typical. I am sure you cannot deny this niichago.

"Shortages (excess demand) and surpluses (excess supply) represent an inefficient use of scarce resources, and economists support market prices because they eliminate shortages and surpluses, and therefore lead to efficiency."

This logic would seem to support the rationale that there are too few businesses (i.e. lack of competition) in the U.S., because of the higher unemployment rate (at least in most metropolitan areas). I guess all of those corporate mergers are doing wonders, because prices keep dropping all over the place.

Face the facts; the lack of competition or good substitutes has more to do with the price of goods and services than with supply and demand, especially in the era of information.

"This logic would seem to support the rationale that there are too few businesses (i.e. lack of competition) in the U.S., because of the higher unemployment rate (at least in most metropolitan areas)."

Anonymous, you have it backwards. The original article has it right; shortages and surpluses are a result of artificial (i.e. government) restraints on price, and this applies just as much to the labour market.

Labour is a scarce resource that the economy can always use more of. When labour goes unused (i.e. unemployment), it's because there are price controls or regulatory controls. More specifically, minimum wage laws that are higher than the market rate prevent workers from selling their labour to employers. Other employment regulations and income tax (which literally penalizes employment) also play a part.

Not really sure that your logic makes a whole lot of sense in this case.

It seems like everyone needed light bulbs and there wasn't enough supply to meet the demand, regardless of what the price was.

They set the official price below the market value...so? Did people buy up all the cheap light bulbs by the truck load just because they could?

The free market price wouldn't have curbed demand. People would have still needed light bulbs whether they were 10 rubles or 10000 rubles.

Yes, usually when there's a short supply of something the price goes up. However, when it's a basic staple of modern life like light bulbs, bread, or water price doesn't matter: there will still be a demand for those products. If there's no supply available then it doesn't matter what the price is.

The lack of supply was due to the massive corruption and failure of the USSR's version of communism, not people buying tons of light bulbs because the price was artificially low!

While light bulbs and other staples have relatively inelastic demand, they are not absolutely inelastic. If the price were set by the market at 10000 rubles due to artifically low supply, then many many people would choose to not buy them and would choose some substitute instead (fix broken bulbs, buy candles, live in the dark, etc). This is in fact a simple matter of price fixing that distorts demand -- exactly as was argued in the article.